Behind the Sell-Off in PetSmart Stock



PetSmart (NASDAQ:PETM) is one of my favorite stores for pet needs. The atmosphere is very friendly, and I enjoy bringing my pets with me to shop for their needs. In general, PetSmart operates as a specialty retailer of products, services, and solutions for pets in the United States, Puerto Rico, and Canada.

The company offers consumables, such as pet food, treats, and litter; and hard goods, which include pet supplies and other goods, consisting of collars, leashes, health care supplies, grooming and beauty aids, toys, apparel, and pet beds and carriers, as well as aquariums and habitats, accessories, décor, and filters for fish, birds, reptiles, and other small pets. It also provides fresh-water fish, small birds, reptiles, and small pets; and pet services, such as dog training, pet grooming, and pet adoption services.

In addition, the company operates PetSmart PetsHotels that offer boarding for dogs and cats; provides personalized pet care, temperature controlled rooms and suites, daily specialty treats and play time, and day camp services for dogs; and operates veterinary hospitals, which offer services comprising routine examinations and vaccinations, dental care, a pharmacy, and surgical procedures. What you may not know is that the company is highly profitable, and the stock has rewarded shareholders over the years. However, today the stock is down 9 percent, plunging after reporting earnings.

Earnings were $1.04 per share which were up 6.1 percent compared to $0.98 per share in the first quarter of 2013. Net income also increased 1.3 percent to $104 million, compared to $102 million in the first quarter of 2013. Net sales for the first quarter of 2014 increased 1.1 percent to $1.7 billion. Comparable store sales, or sales in stores open at least one year, including online sales, fell 0.6 percent, with comparable transactions decreasing 2.2 percent.

Services sales, which are included in net sales, grew 4.5 percent to $200 million. The company generated $137 million in cash flows from operating activities, spent $32 million in capital expenditures, distributed $20 million in dividends, and repurchased $130 million of PetSmartstock. The company ended the quarter with $301 million in cash, cash equivalents and restricted cash and zero borrowings on its credit facility. These numbers were incredibly strong.

David Lenhardt, President and Chief Executive Officer stated, “We are pleased with the company’s ability to achieve earnings per share growth of 6.1 percent while continuing to drive earnings before tax margin expansion during the first quarter. However, we did not achieve our sales goals, which were impacted by a challenging and volatile consumer environment and a competitive market.”

The stock sold off because of these negative comments and the company’s outlook for the remainder of the year. Based on the company’s year-to-date results and updated assumptions for the remainder of the year in light of the consumer environment and competitive market, the company updated its fiscal year 2014 outlook. It sees comparable store sales relatively flat and net sales growth in the low-single digits. It now sees weaker earnings per share between $4.29 to $4.39 and having operating cash flow between $600 and $625 million. For the second quarter, the company sees comparable store sales growth flat to slightly down and having earnings per share of $0.92 to $0.96. The Street is hammering the stock because of this disappointing guidance.

Overall, PetSmart is having a transitional year. It is moving to focus more on higher margin pet services while of course still focusing on lower margin sales. While the company grew earnings year over year, it missed its own sales target. Further, the guidance is relatively weak. That said, the stock yields 1.4 percent and is at new lows of $56.80. I think if the stock dips below $54.00, it is a good entry point to initiate a position.

Disclosure: Christopher F. Davis holds no position in PetSmart and no intentions of initiating a position in the next 72 hours. He has a tentative buy rating on the stock under $54.00.

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